11

- 3011

Martin v. U.S. S.E.C.

1

UNITED STATES COURT OF APPEALS 2

FOR THE SECOND CIRCUIT 3

4 August Term, 2012 5

6 (Argued: April 11, 2013 Decided: O ctober 30, 2013 ) 7

8

Docket No. 11

- 3011 9

10

11

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13

R OBERT A. M ARTIN

, E MPIRE P ROGRAMS

, I NC

., 14

15

Petitioners

, 16

17

v. 18

19

U NITED S TATES S ECURITIES AND E XCHANGE C OMMISSION

, 20

21 Respondent

. 22

23

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25

Before: K ATZMANN

, Chief Judge

, K EARSE

, and D RONEY

, Circuit Judges

. 26

27 Petitioners challenge an order of the Securities and Exchange Commission 28 authorizing disbursement to the United States Treasury of money remaining in 29

Fair Fund s

. We deny the petition on the ground that the Petitioners lack Article 30 III standing to mount their challenge to the order. 31

32

33

34

A LL AN H. C ARLIN , Law Office of 35
Allan H. Carlin, New York, New 36

Y ork, for Petitioners. 37

38
J EFFREY A. B ERGER , Senior Counsel 39 (Luis d e l a Torre, Senior Litigation 402 Counsel, Jacob H. Stillman, Solicitor,

1 Michael A. Conley, Deputy General 2
Counsel, on the brief ), Securities and 3 Exchange Commission, Washington, 4

D istrict of Columbia, for Respondent

. 5

6

P ER C URIAM : 7

8

In 2004, the Securities and Exchange Commission (“SEC”) settled an 9

enforcement action against seven firms that executed trading orders on the New 10

York Stoc k Exchange (“NYSE”)

. Pursuant to the settlement orders, the SEC 11

placed the money obtained as a result of the enforcement actions into funds for 12

distribution to injured customers. After extensive efforts to identify and 13

compensate injured customers, the SEC ordered that the remaining funds be 14

disbursed to the United States Treasury. Seeking to i nvok e this Court’s statutory 15

jurisdiction under 15 U.S.C. § 78y to review certain orders of the SEC, Petitioners 16

challenge the disbursement order. We deny the petition on the ground that the 17

Petitioners lack Article III standing to mount their challenge to the order. 18

19

BACKGROUND 20

21

Empire Programs, Inc. , and its president, Robert A. Martin (collectively

, 22

“Empire”) petition for review of a May 26, 2011 order (the “Order”) of the SEC 23

directing the transfer to the United States Treasury of the balance remaining in 24

the distributive funds (the “Fair Funds”) 1 that were established in accordance 25

1 Sarbanes

- Oxley’s Fair Fund provision permits the SEC to place both disgorgement amounts
and civil penalties in a fund for distribution to defrauded investors: “If in any judicial or
administrative action brought by the Commission under the securities laws (as such term is
defined in section 78c(a)(47) of this title) the Commission obtains an order requiring
disgorgement against any person for a violation of such laws or the rules or regulations3

with settlement agreements that the SEC entered with Bear Wagner Specialists 1

LLC; Fleet Specialist, Inc.; LaBranche & Co. LLC; Spear, Leeds & Kellogg 2

Specialists LLC; Van der Moolen Specialists USA, LLC; Performance Specialist 3

Group LLC; and SIG Specialists

, Inc. ( collectively, the “Specialist Firms”). Empire 4

asserts that the Orde r: (1) violates Section 308(a) of the Sarbanes

- Oxley Act of 5

2002, 15 U.S.C. § 7246(a), regarding the use of civil penalties for the benefit of 6

injured investors; (2) contradicts the terms of the settlement agreements; and (3) 7

is barred by SEC Rule 1102(b), 17 C.F.R. § 201.1102(b). 8

During the relevant time period, each security on the NYSE was assigned 9

to one of the Specialist Firms. Specialist Firms could trade in their assigned 10

securities as either agents or principals. When acting as an agent, a Speciali st 11

Firm would facilitate transactions by investors. To purchase or sell a security, 12

investors were required to present their order to that security’s Specialist Firm. 13

The Specialist Firm would then use a computerized “display book” listing 14

investors’ orders to execute transactions. Specialist Firms were required to quote 15

prices that accurately reflected the prevailing market conditions. When acting as 16

an agent, Specialist Firms were required to match the orders of buyers and 17

sellers, and thus ensure th e execution of trades at the best available price. 18

Specialist Firms could also act as a principal, trading on their own accounts, but 19

only when it was necessary to maintain a fair and orderly market. See In re NYSE 20

Specialists Sec. Litig. , 503 F.3d 89, 92 (2d Cir. 2007). 21

22

thereunder, or such person agrees in settlement of any such ac tion to such disgorgement, and
the Commission also obtains pursuant to such laws a civil penalty against such person, the
amount of such civil penalty shall, on the motion or at the direction of the Commission, be
added to and become part of the disgorgeme nt fund for the benefit of the victims of such
violation.” 15 U.S.C. § 7246(a) (2002). This provision was amended by the Dodd

- Frank Act in a

manner not relevant here.4

I. SEC Enforcement Actions and Settlements 1

2

In 2004, the SEC alleged that the Specialist Firms had used two 3

manipulative tactics: “interpositioning” and “trading ahead.” Both 4

interpositioning and trading ahead involve a Specialist Firm tr ading as a 5

principal even though such trading is unnecessary to maintain a fair and orderly 6

market because there are customers who are prepared to trade with each other. 7

“Interpositioning” refers to the practice of capturing the spread between a buy 8

order and sell order. For example, if one customer has placed an order indicating 9

her willingness to sell a security for $20.00, and another customer has placed an 10

order indicating his willingness to buy the security for $20.01, the Specialist Firm 11

should see bo th orders on the display book for the security and match them, 12

allowing the former customer to sell to the latter at a price of either $20.00 or 13

$20.01. The Specialist Firm could engage in “interpositioning” by purchasing the 14

security for its own account for $20.00 from the former customer and selling the 15

security from its own account to the latter customer for $20.01. By standing 16

between the two customers, the Specialist Firm would reap a $0.01 profit on the 17

trade. 18

“Trading ahead ” refers to the practice of executing proprietary trades 19

ahead of the trades ordered by customers. For example, the Specialist Firm might 20

use its unique access to customers’ orders to determine whether the price of a 21

security is trending up or down. If the Speciali st Firm found that the price of the 22

security would fall, the Specialist Firm could use this knowledge to reap a profit 23

by “trading ahead” of the sell order s

. It would do this by failing to match the buy 24

and sell orders in the display book, and instead sati sfying the buy orders by 25

selling the security out of the Specialist Firm’s own inventory. The Specialist 26

Firm would then wait for the security’s price to fall before replenishing its 275

inventory by satisfying the sell orders

. This would allow the Specialist Firm to 1

transfer the negative impact of the decline from itself to the customers who had 2

sought to sell

. Similarly, if the Specialist Firm found that the price of the security 3

would rise, it could “trade ahead” of the customers who had sought to buy by 4

pur chasing for its own account, waiting for the price increase, then satisfying the 5

customer buy orders by selling from its own inventory

. This would allow the 6

Specialist Firm to capture a price increase that would otherwise accrue to the 7

customers who had so ught to buy

. 8

The SEC alleged that the Specialist Firms had engaged in unlawful 9

interpositioning or trading ahead in a specific set of trades. In order to identify 10

these trades, the SEC used an algorithm that identified situations in which a 11

Specialist Firm had traded for its own account even though a buy order and a 12

matching sell order appeared on the display book. However, the SEC recognized 13

that its algorithm could generate false positives

. A system error or a delay could 14

prevent a Specialist Firm fro m recognizing the match, or the Specialist Firm 15

might have orally executed the trade involving the matching orders. In order to 16

screen out false positives to match orders, the SEC excluded instances in which 17

the orders appeared on the display book for less than ten seconds. 18

The trades in which matching orders sat unexecuted for ten seconds or 19

more ( the “Covered Transactions”) were subject to the SEC’s enforcement action 20

against the Specialist Firms. In the aggregate, these 2.661 million transactions 21

result ed in profits to the Specialist Firms of $157.8 million. Through settlements 22

with the SEC in March and July of 2004 ( the “Settlement Orders”), the Specialist 23

Firms agreed to disgorge these $157.8 million in profits, and to pay additional 24

civil penalties of $89.4 million. The Settlement Orders also provided that the 25

disgorgement and civil penalties would be deposited in Fair Funds for 26

distribution according to a plan drawn up by an administrator. Each Settlement 276

Order provided that the Fair Fund it created would be used “(i) to pay for the 1

costs of administering the [distribution plan]; (ii) to reimburse injured customers 2

for their loss; and (iii) pay prejudgment interest to injured customers. The [SEC] 3

shall determine the appropriate use for the benefit of investors of any funds left 4

in the Distribution Fund following such payments. Under no circumstances shall 5

any part of the [Fair Fund] be returned to [the Specialist Firms].” 6

The SEC established the Fair Funds in October of 2004, and appointed the 7

firm o f Heffler, Radetich & Saitta L

. L

. P

. (“Heffler”) as administrator. In order to 8

distribute funds to the injured customers, Heffler began tracing the Covered 9

Transactions by working with clearing firms. Clearing firms process the final 10

stages of a securities transaction, including delivery. In many instances, the 11

clearing firm could only identify the brokers involved in a transaction, and many 12

of the brokers involved had either destroyed their records or ceased to exist. At 13

the end of this process, Heffler was able to match customers for 77.6% of the 14

Covered Transactions. $159.8 million remained in the Fair Funds because Heffler 15

was unable to match a customer to the remaining 22.4% of the Covered 16

Transactions, and because many of the customers identified eithe r could not be 17

located or failed to cash checks mailed to them. 18

Empire Programs, Inc. was identified as a customer in certain Covered 19

T ransactions, and has received a distribution compensating it for losses it 20

suffered in connection with those transactions

. 21

22

II. Private Class Action 23

24

On October 17, 2003, several private parties including Empire filed class 25

actions against the Specialist Firms. These class actions included similar 26

allegations of interpositioning and trading ahead, but on a diffe rent set of trades. 277

The suits were ultimately consolidated in the United States District Court for the 1

Southern District of New York

. In re NYSE Specialists Sec. Litig. , 503 F.3d at 95

. 2

The defendant Specialist Firms resisted the private litigation by arguing that the 3

relief sought was already covered by the disgorgements obtained by the SEC. 4

The district court rejected this argument, holding that “although the Amended 5

Complaint” in the private action “alleges the same wrongdoing on the part of the 6

Spec ialist Firms as that alleged in the SEC investigation, the instant suit is not 7

duplicative because . . . it only provides for relief for those violative transactions 8

not yet” covered by the SEC enforcement action. In re NYSE Specialists Sec. Litig.

, 9

260 F. R.D. 55, 81 (S.D.N.Y. 2009). The private litigants planned to identify these 10

additional trades by modifying the computer algorithm used by the SEC. For 11

example, the SEC action only addressed Specialist Firm trades for which 12

matching buy and sell orders had appeared on the display book for at least ten 13

seconds. The private plaintiffs’ suit addressed trades for which buy and sell 14

orders appeared for a period between one and ten seconds. Id. at 67. 15

16

III. SEC Decision to Transfer Remaining Funds to the U.S. Treasury 17

18

Once Heffler’s efforts to disburse the funds had concluded

, the SEC 19

solicited public comments on the disposition of the remaining funds. After 20

considering the comments, the SEC entered the Order, which directed the 21

transfer of the remaining fun ds to the United States Treasury. In reaching this 22

decision, the SEC rejected Empire’s contention that Heffler had failed to identify 23

injured customers through “indifference or incompetence (or some other 24

unknown reason).” The SEC concluded that Heffler ha d “engaged in a 25

painstaking process to identify, and distribute disgorgement to, harmed 26

investors,” and “that further efforts to identify previously unidentified investors 278

whose transactions were the subject of the settlement orders would not be 1

reasonable or appropriate under the circumstances here. . . . [F]urther efforts are 2

unlikely to be fruitful.” 3

The SEC also rejected various alternatives. The first option, supported by 4

Empire and the Specialist Firms, was to disburse the remaining funds to the 5

plai ntiffs in the private class action. The SEC concluded that this would be 6

unwise because it would indirectly reduce the Specialist Firms’ liability: “If the 7

undistributed funds were used to settle related litigations . . . Defendants would 8

benefit from not having to pay those settlements with their own money.” The 9

SEC also rejected Empire’s argument that “the remaining funds [should] be used 10

to compensate investors who were injured in transactions not covered by the 11

settlements,” observing that “[h]ad the [S EC] included other transactions as part 12

of the settlements, the terms of the settlements would have been different.” 13

Empire also endorsed a second option, distributing the remaining funds 14

pro rata to the previously identified (and previously reimbursed) i njured 15

customers. Empire supported this option by observing that there was no 16

assurance that Empire had “received reimbursement anywhere near 100% of its 17

actual losses.” The SEC rejected this argument. Empire had been fully 18

compensated for every Covered Tr ansaction for which it was identified as the 19

injured customer. The SEC acknowledged that “it is possible that some 20

customers who were fully compensated for their losses with respect to a 21

particular transaction may have also suffered a loss with respect to another 22

transaction that was part of the settlement, but where, for one reason or another, 23

the customer could not be identified as linked to the loss.” But the SEC 24

responded that “there is no requirement that a plan administrator compensate 25

any person for losses that cannot be substantiated. Indeed, Empire points to 26

nothing more than supposition to support its assertion that neither it nor any 279

other identified investor has received 100% of losses from transactions covered 1

by the settlements.” The SEC thus c oncluded that a pro rata distribution would 2

amount to an undeserved windfall to the previously identified customers. 3

Accordingly, the SEC decided to distribute the remaining funds to the U.S. 4

Treasury. 5

6

DISCUSSION 7

8

We find that Empire has failed to plead an injury in fact sufficient to afford 9

it Article III standing. Consequently, we dismiss the petition for lack of subject 10

matter jurisdiction and decline to reach the merits of Empire’s claims , except to 11

the extent that the merits overlap with the jurisdic tional question

. Article III 12

standing enforces the Constitution’s case

- or

- controversy requirement. See Lujan 13

v. Defenders of Wildlife , 504 U.S. 555, 560 (1992); see also U.S. Const. a rt . III, § 2. To 14

establish standing pursuant to Article III, “the plainti ff must have suffered an 15

injury in fact

– an invasion of a legally protected interest which is (a) concrete and 16

particularized; and (b) actual or imminent, not conjectural or hypothetical.” 17

Lujan , 504 U.S. at 560 (emphasis added ) ( citations, footnote

, and internal 18

quotation marks omitted). Significantly, when a “plaintiff is not himself the 19

object of the government action or inaction he challenges, standing is not 20

precluded, but it is ordinarily ‘substantially more difficult’ to establish.” Id. at 562 21

(quoting Allen v. Wright , 468 U.S. 737, 758 (1984)). Empire’s asserted injuries 22

cannot satisfy these standards. Instead, Empire’s injuries fall into one of three 23

categories: fully compensated, conjectural, or based on alleged violations not 24

covered by the settlements. 25

The settlement agreements with the Specialist Firms only address Covered 26

Transactions. See Petitioner’s Br. at 37 (“The Settlement Orders . . . were . . . 2710

predicated on the proposition that the SEC and NYSE had identified specific 1

Violative Transactions in which customers were disadvantaged by improper 2

proprietary trading by the Specialist Firms, and had calculated the amount of 3

customer losses attributable to the Violative Transactions.”). 2 For every Covered 4

Transaction in which Empire was identified as the injured customer, Empire has 5

already received a distribution from the Fair Funds that fully compensated it for 6

that Covered Transaction. 7

Admittedly, there were a substantial number of Covered Transactions for 8

which it was not possible to identify the injured customer. It is possible that 9

Empire was the injured customer in some of those transactions, but only 10

possible : Empire has not identified any such injury, nor has it suggested a 11

method for making such identifications. This type of hypo thetical or conjectural 12

injury is not sufficient to confer standing. See Lujan , 504 U.S. at 560. 13

The only remaining “injury” that Empire seeks to redress is harm caused 14

by transactions that were not contemplated by the settlement agreements. 15

Empire cannot assert a legal claim to the remaining assets in the Fair Funds 16

based on these transactions. Empire has brought a private law suit against the 17

Specialist Firms to pursue monetary relief for any injuries caused by non

- covered 18

transactions. But any injuries t hat Empire might have suffered in non

- covered 19

transactions do not give it an interest in the remaining funds from a settlement 20

based on Covered Transactions

. 21

This Court’s decision in Official Comm ittee of Unsecured Creditors of 22

WorldCom, Inc. v. SEC , 467 F.3d 73 (2d Cir. 2006) (“ Official Committee ”)

, does not 23

compel a different result

. Official Committee considered part of the fallout from 24

2 In its reply brief, Empire suggests that the SEC did not intend for the Settlement Agr eement to cover only a certain set of transactions. This assertion is not only incorrect, but inconsistent with
statements in Empire’s opening brief and with its position before the district court in the private
class action against the Specialist Firms.11

WorldCom’s massive accounting fraud and its subsequent bankruptcy. In the 1

wake of the accounting fraud, the SEC brought suit against WorldCom. The SEC 2

subsequently sought and obtained approval of a monetary settlement from the 3

United States District Court for the Southern District of New York. See SEC v. 4

WorldCom, Inc. , 273 F. Supp. 2d 431 (S.D.N.Y. 2003). The SEC s et aside the money 5

in a fair fund. After WorldCom emerged from bankruptcy under Chapter 11 of 6

the Bankruptcy Code , the SEC sought to distribute the fair fund pursuant to a 7

distribution plan that excluded certain investors. 8

In Official Committee , this Court approved the SEC’s decision to exclude 9

those investors from the fair fund distributions despite objections by the Official 10

Committee of Unsecured Creditors from the bankruptcy proceedings

. 467 F.3d at 11

84

- 85

. Prior to reaching a review of the district court’s approval of the 12

distribution plan , we paused to analyze the Official Committee’s ability to bring 13

its challenge in court. In the context of a discussion focused on the Official 14

Committee’s nonparty standing to appeal from a district court judgment

, we 15

briefly observed that the Official “Committee’s Article III standing is 16

uncontested, and we are satisfied, on the basis of the limited record before us, 17

that the constitutional requirements are met: Because the Committee is 18

composed of creditors who su ffered economic injuries that are fairly traceable to 19

WorldCom’s violations of the securities laws, and because it seeks financial 20

compensation to redress those losses, the Committee meets the requirements for 21

Article III standing.” Id. at 77. 3 However , unlike the situation in Official 22

Committee

, to the extent that Empire has suffered substantiated economic injuries 23

3 The SEC contends that injured investors never have “Article III standing to challenge
Commission orders regarding the disposition of Fair Fund money.” Respondent’s Br. at 30. As
the SEC itself acknowledges, we need not address this argument in order to re solve this case.12

that are fairly traceable to the securities law violations that gave rise to the 1

Settlement Orders, those economic injuries have already be en fully redressed. 2

3

CONCLUSION 4

5

For the foregoing reasons, the petition for review is hereby DISMISSED

. 6